Investing 101: Understanding Investment Vehicles and Account Strategies

The arcane world of investing isn't just for money managers anymore. You need cliff notes these days because even financial professionals don't know it all. Even if they are knowledgeable, you can't always guarantee that you're getting accurate or objective advice. Don't just rush in and buy the next hot stock being pumped on MSNBC. Take a few minutes to learn how serious investors diversify their portfolio.

Traditional IRAs: Traditional Individual Retirement Accounts (IRAs) are special investment accounts that the IRS has deemed "off limits" in as far as taxes are concerned. The catch? You have to deposit money into the account and leave it there until you reach age 59 1/2 or face a 10 percent tax penalty. There are a few loopholes in the law, of course, but you shouldn't think of this as a "fling." Be prepared to make a long-term commitment once you open one of these things.

Money is normally deposited on a tax-deferred basis (i.e. you get a tax deduction at the end of the year equal to your contribution) up to the contribution limit for the year. Since the contribution limits change almost every year, you'll have to keep up with IRS publication 590 and for the most recent contribution limits.

Roth IRAs: Roth IRS are a bit backwards from the traditional IRA. Instead of contributing money on a tax deductible basis, and having all withdrawals taxed at ordinary income tax rates, you make contributions on a non-deductible basis. Then, when you make withdrawals, all money is income tax-free. The same rules and exceptions apply for early withdrawals with one major advantage going to the Roth. You can withdraw your contribution amounts at any time, for any reason, without paying a penalty or tax (since the money was already taxed).

Money Markets: No, this isn't where you can shop for money. The money market is a collection of various short-term investments like Treasury bills, commercial paper, bank CDs, and other investments that have a maturity of less than one year. Because these investments are so short-term, the risk of loss in a money market is very low. Money markets are often offered by banks and insurance companies as a way to store your money until you figure out a long-term strategy.

Bonds: A bond is a debt instrument literally a loan. Imagine loaning money to your friend, except that this friend usually has billions of dollars worth of income to repay you. Bonds are considered fairly safe and pay a guaranteed rate of return. Zero coupon bonds allow you to purchase the bond at a discount to the face value. For example, a $50 bond may sell for $30. To get the $50, you must wait a specified period of time. Other bonds bear interest. In other words, you get paid interest every year on your investment principal. Either way, you're guaranteed to receive a specific amount of money when the bond is fully mature (i.e. after a set period of time).

Stocks: Stocks represent partial ownership in a corporation. When you buy a stock, you share in the profits and loss of the company. However, your loss is limited to the amount of money you put in.   Managed Mutual Funds   Don't want to manage money on your own? There's a fund for that. Literally. Managed mutual funds allow you to hire a professional to manage your investments for you. For a fee, you will get expert investment advice in the form of a managed portfolio of stocks, bonds, and other choice investments.

Index Mutual Funds: Managed mutual funds have a major drawback: statistically speaking, most managed funds fail to outperform their benchmark. That means money managers set a performance target (i.e. the passive returns of the stock market) and often fall short of the mark after fees and taxes are taken into account. Unless you're very confident in your money manager, an index fund is cheaper and probably going to offer superior returns over the long-term.

An keen understanding of the Seven Investment Vehicles is a great basis for any investor that is developing a strategy. There is also a lot of wisdom in setting up a separate bank account for investment purposes, as all too often beginner investors use private accounts or credit cards and quickly lose track of their movements. 

You can read more on different accounts here. Seeking advice from seasoned investors is never something you should shy from. Are you a beginner at investing or a seasoned hack? What strategies see you to the greener pastures

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